We’re talking about #finance on many Fridays — for non-finance people, getting into some of the fundamentals that were parts of the SVB collapse:

Particularly, let’s talk about #bonds and the importance of bonds in the economy and in a balanced investment portfolio
Then there’s #treasury function’s role in a bank and how bonds relate to the responsibilities of #treasurymanagement
Then, let’s get into how an investment firm or bank usually handles bonds, and why having #longtermsecurities, particularly bonds, can be risky — when the interest rates change a lot
Let’s have a really simple way of thinking about bond yields and bond value

Understand Bonds and their Role in the Economy and Investment Portfolios

Bonds are a type of fixed-income security that represent a loan made by an investor to a borrower, typically a corporation or government.

When you buy a bond, you are essentially lending money to the borrower, who agrees to pay you back the principal amount plus interest over a specified period of time.

Bonds are important to the economy because they provide a way for corporations and governments to finance their operations and projects.
By issuing bonds, these entities can raise money without having to give up ownership or control of the organization.
Bonds also help to set a benchmark interest rate for other borrowing in the economy, which can influence other interest rates.

In terms of investment portfolios, bonds play an important role in providing diversification and reducing risk.

Unlike stocks, which can be volatile and subject to large fluctuations in price, bonds generally offer a more stable return and can help to balance out the risks in a portfolio. Additionally, bonds can provide a source of income in the form of interest payments, which can be especially important for retirees or those looking for a steady stream of cash flow.
Investment firms and banks typically handle bonds by buying and selling them on behalf of their clients. When an investor buys a bond, the investment firm or bank may hold onto the bond until it matures or sell it to another investor. The value of the bond can fluctuate based on changes in interest rates and other market factors.

Bond yields are the way to compare rate of return

Yield is the rate of return an investor can expect to receive on a bond, taking into account the price of the bond and the interest payments it generates.

When interest rates rise, bond prices typically fall, and the yield on the bond increases.
Conversely, when interest rates fall, bond prices typically rise, and the yield on the bond decreases.

Imagine buying a bond for $1,000 paying 5% per year

This means you will receive $50 in interest payments each year.
However, if interest rates in the market rise to 6%, then the bond you bought may become less attractive to other investors, who can now buy new bonds that pay a higher yield.

In order to sell your bond, you may need to lower the price to make it more appealing to potential buyers.

If you sell the bond for $950, for example, then the yield would increase from 5% to 5.26% ($50/$950), making it more competitive with the new bonds being offered in the market.

Overall, bonds can be a valuable component of a balanced investment portfolio, providing stability and income. However, it’s important to understand the risks associated with investing in bonds, particularly if interest rates fluctuate significantly.

Paint a simple picture for me: why do rising interest rates spell trouble for bond value?

Here’s a simple way to think about it.

Imagine you own a bond that pays 3% interest per year, and interest rates in the market suddenly increase to 4%. New bonds are now available that pay a higher yield than your bond.

Investors who are looking to buy bonds will be more interested in the new bonds that offer a higher yield than your bond. In order to sell your bond, you may need to offer it at a lower price so that the yield on your bond becomes more competitive with the new bonds being offered in the market.
This decrease in price of your bond results in a decrease in its value, because the bond is now worth less than what you originally paid for it.

This is why an increase in interest rates can spell trouble for bond values, because as interest rates rise, the prices of existing bonds tend to fall in order to make them more competitive with newer bonds that offer a higher yield.

What are bank treasury services? What’s the responsibility of the treasury?

Why is it one of the most important functions inside a bank or other financial company?
How is risk usually managed?
How is oversight managed, both within the company and with other, outside entities, like an accounting firm, consulting firm looking at mark-to-market value, and stress tests?

Treasury departments are responsible for managing the bank’s balance sheet, which includes its assets, liabilities, and capital

Bank treasury services refer to a broad range of activities within a bank or financial institution that are related to managing the bank’s liquidity, capital, and risk.

The treasury’s responsibilities include managing the bank’s cash and liquidity, investing excess cash in short-term instruments, managing the bank’s risk exposure, and ensuring compliance with regulatory requirements.

They are also responsible for monitoring the bank’s financial performance and making recommendations to senior management for improving profitability and reducing risk.

The treasury function is considered one of the most important functions within a bank or financial company because it plays a crucial role in ensuring the bank’s financial stability and profitability

The treasury department is responsible for managing the bank’s balance sheet and ensuring that the bank has adequate liquidity to meet its obligations, even during times of stress or crisis.

Risk management is a critical aspect of the treasury function

Treasury departments use a variety of tools and techniques to manage risk, including hedging strategies, portfolio diversification, stress testing, and risk modeling. They work closely with other departments within the bank, such as credit risk management and market risk management, to identify and mitigate potential risks.

Oversight of the treasury function is typically managed internally through the bank’s own risk management and compliance functions, as well as through regular reporting to senior management and the board of directors. External oversight may also be provided by regulatory agencies, accounting firms, and consulting firms, who may review the bank’s financial statements and conduct audits to ensure compliance with regulatory requirements and best practices.

What does mark-to-market mean in accounting?

Mark-to-market accounting is an important tool for measuring the value of the bank’s assets and liabilities on a regular basis. This involves assigning a current market value to each asset and liability on the bank’s balance sheet, which allows the bank to track its financial performance and make informed decisions about its investments and risk management strategies. Stress tests are also commonly used by treasury departments to assess the bank’s ability to withstand various types of market shocks and crises, and to identify potential areas of weakness in the bank’s balance sheet.

What are stress tests, and how are they usually carried out since 2009?

Stress tests are simulations or scenarios that are used to assess the financial strength of banks and other financial institutions. They are designed to evaluate how well banks can withstand different types of economic or financial shocks, such as a recession, a sudden increase in interest rates, or a decline in asset prices.

In the wake of the 2008 financial crisis, stress tests became an important tool for regulators to assess the resilience of banks and the overall stability of the financial system. In the United States, stress tests are now a mandatory requirement for all banks that have more than $10 billion in assets.

The stress testing process typically involves three main steps:

Scenario design: Regulators or supervisors design scenarios that reflect different types of economic or financial shocks, such as a recession or a decline in asset prices.
Data collection: Banks are required to provide data on their balance sheets, risk exposures, and other relevant information. The data is used to assess how the bank’s financial position would be affected by the scenarios.
Analysis and reporting: Regulators or supervisors analyze the data provided by banks and assess their ability to withstand the scenarios. The results are typically reported publicly, and banks that fail the stress test may be required to take corrective action to improve their financial position.

Since 2009, stress tests have become increasingly rigorous and comprehensive. Regulators have designed more complex scenarios and have required banks to provide more detailed data. In addition, stress tests have become more frequent, with some banks now required to undergo stress tests twice a year.

Stress tests are a critical tool for ensuring the stability of the financial system and reducing the risk of another financial crisis. By assessing the ability of banks to withstand economic and financial shocks, stress tests help to identify potential areas of weakness and encourage banks to take corrective action to improve their resilience.

What contributed to interest rates being so low for so long, and when did that start and what was before, for those who don’t remember, and for those in the back?

Interest rates have been historically low for more than a decade in many countries, including the United States, Japan, and much of Europe. The low-interest-rate environment began after the 2008 financial crisis when central banks around the world implemented monetary policies to support economic growth and stabilize financial markets.

After the 2008 financial crisis, the global economy entered a period of sluggish growth and low inflation. In response, central banks around the world, including the US Federal Reserve, the European Central Bank, and the Bank of Japan, implemented policies to reduce interest rates and stimulate economic activity. These policies included cutting short-term interest rates to near zero and implementing quantitative easing programs, which involved buying large amounts of government bonds and other securities to inject liquidity into the financial system.

The goal of these policies was to encourage borrowing and investment, stimulate economic growth, and prevent deflation. However, the low-interest-rate environment persisted for a long time, even after the global economy began to recover, due to a variety of factors, including structural changes in the economy, demographic shifts, and subdued inflation.

Low interest rates can have both positive and negative effects. They can make borrowing cheaper, which can encourage investment and stimulate economic growth. However, they can also lead to asset bubbles and excessive risk-taking, as investors search for higher returns in a low-yield environment. They can also make it more difficult for savers and retirees to earn a decent return on their investments.

Overall, the prolonged period of low-interest rates has had significant implications for the global economy and financial markets, and it remains an important topic of debate among policymakers, economists, and investors.

What happens when there’s overinvestment in speculative industries, but not a lot of investment in people-centered innovation in food, sustainable housing, and sustainable clothing and textiles as well as other materials used for increasing the quality of life for more people?

When there’s overinvestment in speculative industries, such as those that rely heavily on short-term profit and high-risk investments, it can lead to market bubbles, financial instability, and economic downturns. This is because investment in these industries is often driven by speculation and momentum, rather than sound economic fundamentals. When the bubble bursts, it can lead to significant losses for investors and damage to the broader economy.

On the other hand, when there’s not enough investment in people-centered innovation in areas such as sustainable food, housing, and textiles, it can have negative consequences for society and the environment. This is because these areas are critical for improving the quality of life for people and reducing our impact on the environment. Without sufficient investment, progress in these areas can be slow, and the benefits of innovation may not be realized.

Overall, it’s important to strike a balance between investment in speculative industries and investment in people-centered innovation. This requires a long-term perspective that takes into account not only short-term profits but also the broader social and environmental impacts of investment decisions. By investing in sustainable food, housing, and textiles, we can create a more equitable and sustainable future for everyone.

We can ensure positive impacts for people across diverse class experiences

One way to ensure that investment and innovation have a positive impact on people from all backgrounds is to prioritize inclusivity and diversity in decision-making processes.

This means engaging with and listening to a diverse range of stakeholders, including people from marginalized communities and those with lived experience of the issues being addressed.

This can help ensure investment and innovation strategies respond to the needs and perspectives of a wide range of people, not just those who are already privileged.

Prioritize investments in areas that address systemic inequalities and promote social justice

This can include investing in affordable housing, access to quality education, healthcare, and clean energy

By investing in these areas, we can help reduce disparities in access to basic needs and services that can have a profound impact on people’s quality of life.

In addition, it’s important to measure and track the social impact of investments and innovation.
This requires setting clear social impact goals and metrics and regularly monitoring progress towards these goals.
This can help ensure that the investments and innovations are delivering real benefits to people, especially those from marginalized communities.

Overall, ensuring that investments and innovation have a positive impact on people from all class backgrounds requires a deliberate and intentional approach that prioritizes inclusivity, diversity, and social justice. By doing so, we can create a more equitable and sustainable future for everyone.

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The Shocking Truth Behind the Bank Run: How Treasury Mismanagement Led to the SVB Crisis due to Bond Market Volatility (ps: not diversity priorities)